Opinion: Why the Fed should just stop talking

Federal Reserve Vice Chairman Stanley Fischer says it’s pointless to give any guidance about what the Fed is going to do, because even the Fed doesn’t know.

The Federal Reserve has come under attack in recent weeks, not for what it is doing (nothing) but for what it is saying (a lot). To hear journalists tell it, the Fed’s “communication problem” is a reflection of too many policy makers saying too much about too little, confusing everyone in the process.

In the last two decades, the Fed has evolved from an institution that guarded its policy actions, both actual and prospective, to one committed to absolute transparency. Forward guidance was elevated to a policy tool to insulate financial markets from the slightest surprise.

How’s that working out? There is an inherent contradiction to transparency, something Fed Vice Chairman Stanley Fischer emphasized before he joined the Fed.

“You can’t expect the Fed to spell out what it’s going to do,” Fischer said at a conference in Hong Kong in September 2013. “Why? Because it doesn’t know.”

There’s the rub. The Fed can talk all it wants about fulfilling its dual mandate of full employment and stable prices. It can establish targets or thresholds for normalizing rates (an unemployment rate of 6.5%). It can provide specific calendar guidance or non-specific timelines (”a considerable time”). It can fall back on squishy goals (”some further improvement in the labor market”) and psychobabble (”reasonably confident” inflation will rise), all of which it has tried.

But policy makers don’t know what constitutes full employment. Thresholds, once breached, melt away. “Considerable time” is relative; Fed chief Janet Yellen had to translate — six months — for us at a press conference. And calendar guidance has become a moving target. Over the last few years, the Fed has pledged to hold the funds rate at exceptionally low levels “at least through mid-2013,” which morphed into “late 2014,” “mid-2015,” and “sometime later this year.”

Later this year is now. The Fed meets Tuesday and Wednesday, and few, if any, observers expect any change in policy or the statement released at 2 p.m. Eastern on Wednesday. The Fed has one final meeting on Dec. 15-16. Anyone for 2016?

Bottom line: The Fed is clear only to the extent that one has good visibility in an early-morning fog at the seashore. Clarity in Fedspeak is different from clarity in regular speak.

For example, if you said to your husband, “I think we should take a vacation sometime next year,” would that be sufficient for him to block out time on his calendar? Of course not.

In December 2014, two months after the Fed ended its asset-purchase program, the Fed suggested it could be “patient in beginning to normalize the stance of monetary policy.” Yellen put us on alert: the elimination of “patient” from the statement would mean no rate increases for at least two meetings. (”Patient” disappeared from the statement in March, but the Fed is likely to remain patient into next year.)

Why not say it outright? Ah, because the Fed 1) isn’t sure and 2) doesn’t want to sacrifice its flexibility to respond to the latest economic developments by being too specific about its intentions.

Which brings us to another bugaboo of mine. The meeting minutes often suggest policy makers are waiting for more data… to do what, exactly? Confirm growth in nonfarm employment has been averaging 200,000 a month or better for the last three years? What will one more employment report do to alter perceptions about the labor market?

The pendulum seems to have swung from one extreme to the other.

The Fed’s pre-1994 modus operandi was to keep everything secret — except for a few well-placed leaks to favored journalists and newspapers (yes, remember them?). Even after the fact, no one knew for sure what the Fed had done. Economists made weekly reserve projections to determine what the banking system would need based on a given deposit base. If the Fed overprovided or underprovided what was needed to keep the funds rate stable, economists deduced there had been a policy change. Anointed journalists confirmed economists’ suspicions.

In retrospect, it all seems quite silly. In today’s world, the funds rate doesn’t matter, and the Fed is paying banks interest on the $2.6 trillion of excess reserves they have on deposit at the Fed. The interest rate on excess reserves is expected to play a key role in the normalization process.

What does the Fed have to show for all its talk? Financial markets have consistently ignored the Fed’s guidance. Fed projections for the funds rate, published four times a year, have followed the markets and have consistently been marked down, not the other way around. The odds of a rate hike don’t exceed 50% until March 2016, according to the Chicago Mercantile Exchange’s FedWatch tool.

Maybe it’s time for the Fed to rethink its communication strategy once again — not because it’s the problem some claim it is but because it has become largely irrelevant. Fischer highlighted the innate contradiction of trying to telegraph the Fed’s actions when the future is always uncertain. The shortcomings of forward guidance should be obvious, especially when compared to the Fed’s previous informal policy rules, such as the Taylor Rule or even an implicit inflation target.

Fed communication may have been stuck in the Dark Ages prior to 1994, but Fed policy was a lot more transparent, and predictable, with a reliable policy rule. The goal should be to find one that works.

Caroline
Baum

Caroline Baum is an award-winning journalist who has been writing about the U.S. economy for three decades.

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